Thursday, August 8, 2013

Gold Backwardation Has Only Happened Twice

Gold backwardation is an abnormal condition, but theory and practice are different things. It is extremely rare for gold to be in backwardation, but it does happen when governments intervene in the market process. In this regard, gold is different from crude oil, soybeans and all other commodities, any and all of which can be – and frequently are – in backwardation. Gold has an interest rate. Lumber, sugar, corn and all other commodities do not. Their “cost of carry” to determine their future price is based mainly on warehousing fees that need to be paid for their storage.

More to the point, gold is money because it is accumulated. Essentially all the gold mined throughout history exists in its aboveground stock, whereas commodities get consumed and disappear. They are not money, as I explain in The Aboveground Gold Stock: Its Importance and Its Size.

So while commodity backwardation is not a unique event, gold backwardation is rare. Even though gold backwardation cannot happen in theory, it does occur when government intervention loses its desired effect, meaning that market forces are overpowering government attempts at manipulation.

Until now gold backwardation has only happened two times since this bull market in gold began back in 1999, and each prior occurrence lasted only a few days. In both instances market forces briefly overpowered government interventions aimed at manipulating interest rates. So gold backwardation does occasionally occur in spite of government intervention because central banks cannot “print” physical gold to alleviate demand pressures.